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Here’s why restaurant chains aren’t going public right now

RB’s The Bottom Line examines the poor record of the last generation of IPOs and what it would take for another chain to go public.
Photograph: Shutterstock

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On Monday, Bojangles' Famous Chicken 'n Biscuits completed its sale to a pair of private-equity groups and, in the process, removed yet another growth chain from the roster of publicly traded companies.

In so doing, it highlighted the challenges of the generation of chains that went public from 2013 through 2015, when eager investors bid up valuations for restaurant initial public offerings only to sour on them quickly.

Of the 10 mostly fast-casual chains that went public over that period, three of them have since been taken private, and a fourth, Papa Murphy’s Pizza, is currently for sale.

The three chains that have been sold, which also include Zoes Kitchen and Fogo de Chao, were sold for prices lower than their initial offerings. Papa Murphy’s, meanwhile, is trading at less than half of its 2014 IPO price of $11.

Of the remaining six, half of them are currently above their offering levels: Wingstop, Shake Shack and El Pollo Loco.

For the most part, however, the companies lost value: Their median change from the IPO price has been a decline of 18%.

IPO Price change

To understand how dramatically the companies’ fortunes changed, you have to go back to that era, in which investors were bidding ridiculous prices for growth chains.

Wall Street was eager to get in on the ground floor, hoping to latch onto a company that could take off the way Chipotle Mexican Grill did after its 2006 IPO. “The next Chipotle” labels were thrown around way too quickly during this period.

Four of the 10 companies more than doubled on their first day of trading, and the 10 companies saw first-day increases averaging 72.6%. Shake Shack priced its stock at $21, and at one time was nearing $100 a share before coming back down into the mid-$40s.

The enthusiasm for these companies was such that many large private-equity firms were investing in upstart concepts in a bid to find their own gold mine. Some entrepreneurs with no industry experience were jumping into the business, sensing an opportunity to latch onto the fast-casual boom.

On top of that, new federal rules encouraged smaller companies to test the public markets. Companies are now able to file their initial IPO documents privately. As a result, a lot of small restaurant chains that might have been sold to private-equity firms went public instead.

As it turned out, many of these companies were too small.

Zoes Kitchen, for instance, was the poster child for a too-quick IPO. The company generated an adjusted EBITDA of $10.9 million and had just 103 locations when it filed its registration documents.

The problem with such offerings is that the younger a restaurant chain is, the riskier the investment. Growth chains run into problems, especially as they test new markets and expand beyond core areas.

Many companies simply don’t do well as larger chains, but there is intense pressure on small chains to add units, even to their own detriment.

Problems that I recently examined at Pollo Tropical and Kona Grill were at least in part rooted in challenges both companies had moving into markets where they were less familiar.

On top of that, public equity investors have been rightly spooked by the generally weak performance of the chain restaurant industry. And smaller chains have less ability to invest behind technology and other customer-facing efforts that the big players have been able to use to support sales.

All of that said, the performance of the 2013-2015 IPOs is probably what you’d expect when you get a group of riskier companies on the public markets at a time when the overall market is generally weak.

It’s no surprise, then, that Wingstop, maybe the most established of the growth chains to have gone public during that period, has also been the best performing. The Dallas-based company was the best-performing restaurant stock of 2018 and has now increased 250% since its offering.  

What’s the result of all this? Well, chains that might have gone public (such as breakfast and lunch concept First Watch) were instead sold to other private-equity firms, just like what happened before the IPO boom.

Institutional investors simply have no appetite for the risk that small companies present. While they would welcome a strong chain to the public markets, that strong chain would have to look more like Wingstop and less like Zoes.

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